Fixed income Security
A fixed-income security is an investment that provides a return in the form of fixed periodic interest payments and the eventual return of principal at maturity. Unlike variable-income securities, where payments change based on some underlying measure such as short-term interest rates the payments of a fixed-income security are known in advance.
Fixed-Income securities are debt instruments that pay a fixed amount of interest in the form of coupon payments to investors. The interest payments are typically made semiannually while the principal invested returns to the investor at maturity. Bonds are the most common form of fixed-income securities. Companies raise capital by issuing fixed-income products to investors.
A bond is an investment product that is issued by corporations and governments to raise funds to finance projects and fund operations. Bonds are mostly comprised of corporate bonds and government bonds and can have various maturities and face value amounts. The face value is the amount the investor will receive when the bond matures.
Credit Rating Fixed Income Securities
Not all bonds are created equal meaning they have different credit ratings assigned to them based on the financial viability of the issuer. Credit ratings are part of a grading system performed by credit-rating agencies. These agencies measure the creditworthiness of corporate and government bonds and the entities ability to repay these loans. Credit ratings are helpful to investors since they indicate the risks involved in investing.
Bonds can either be investment grade on non-investment grade bonds. Investment grade bonds are issued by stable companies with a low risk of default and, therefore, have lower interest rates than non-investment grade bonds. Non-investment grade bonds, also known as junk bonds or high-yield bonds, have very low credit ratings due to a high probability of the corporate issuer defaulting on its interest payments.
Equity shares are floated in the market at face value, or at a premium or at a discount. Only companies with a track record or companies floated by other firms/companies with a track record are allowed to charge a premium. The premium is normally arrived at after detailed discussions with the merchant bankers. This is the first exercise involving the valuation of share by the company itself. After allotment of shares to the shareholders, the company may distribute its surplus profits as returns to investors. The returns to equity shareholders are in the form of distribution of business profits. This is termed as declaration of dividends. Dividends are declared only out of the profits of the company. Dividends are paid in the form of cash and are called cash dividends. When shares are issued additionally to the existing investors in the form of returns, they are called bonus shares. These decisions are taken in the annual general meeting of the shareholders. The announcement of dividend is followed by the book closure dates, when the register of shareholders maintained by the company is closed till the distribution of dividends. The shareholders whose names appear on the register on the date are entitled to receive the dividend payment. Cash dividend payments reduce the cash balance of the company while bonus share payments reduce the reserve position of the company.
Thus, the dividends are a direct benefit from the company to its owners. It is an income stream to the owners of equity capital. Many expectations surround the company’s quarterly announcement periods in terms of the dividend declared by the corporate enterprises to its shareholders. The payment of dividend itself is expected to influence the share price of the company. To the extent that cash goes out of the company, the book value of the company stands reduced and it is theoretically expected to lower the market price of the share. This is based on the argument that future expectations are exchanged for current benefits from the company in the form of dividends.
While bonus shares do not reduce the cash flow of the company, they increase the future obligations of the company to pay extra dividend in the future. Bonus shares result in an increase in the number of existing shares. Hence, the company has to pay dividend on its newly issued bonus shares in addition to its existing number of shares. These bonus shares are different from stock splits. Stock splits simply imply a reduction in the face value of the instrument with an increase in the quantity of stock. A stock split does not increase the value of current equity capital. Bonus shares, on the other hand, increase the value of equity capital to the company. All these exercises by the company call for a renewed valuation of the shares traded in the secondary market. Hence, investment evaluation begins with the computation of the value of securities.